Saturday, 9 August 2014

Analysis of CSC ‘s Q1 FY2014 earnings release increased our level of
concern about the company’s outlook and direction. It confirmed our misgivings,
and those of many of our correspondents, about the underlying level of
sustainable profit in today’s CSC.

As ever, CEO Mike Lawrie gave a professional
performance during the Analyst Conference focusing on the positive aspects of
the Q1 results and talking up CSC’s prospects. In fact, just listening to Mr. Lawrie
without looking at any numbers gave the impression everything was going to
plan, the only problem being the failure of the recently-departed Head of GBS to
manage his business adequately. As usual, Mr. Lawrie was helped by a series of
soft questions from the analysts who showed their usual level of docility.

Nor was there anything remarkable or exciting about
the company’s Q1FY2015 results release. CSC
once more exceeded the Analysts’ consensus on its profitability and, unusually,
did manage to exceed the consensus on Q1 revenue; also the rate of
revenue decline slowed.

However, looking beyond Mr Lawrie’s positivity and the
company’s exceeding the analysts’ expectations, there were items which gave us real
concern:

·Revenue continued to decline, being
2% lower, in constant currency, than the equivalent figure of the previous
year.

·EBIT for Q1 FY2015 dropped to 7.7%
from 8.3% a year ago. This was despite the cost take-out and involuntary
vacation in the quarter; also despite a change in pension accounting policy
which yielded a profit boost of US$21 million in the quarter, and despite Q1
FY2015 having an extra week, which yielded a one-off benefit of at least US$
39million and maybe anything up to US$119 million.

·New Business awards for the quarter
were a disappointing US$2.7 billion, being 15% below the level required to
simply replenish the pipeline. Yet
another indicator of a shrinking business.

This begs the question "What would EBIT (Earnings Before Interest and Tax) have been without these one-off benefits?

It is a pity no analyst asked about this; unsurprisingly CSC did not volunteer the information.

We estimate that these one-offs could have accounted for US$96 million of EBIT. If so this would bring underlying EBIT down to US$152 million, or 4.7% rather than the reported US$248 million or 7.7%. A significant difference that is 46% lower than last year and needs explaining.

This difference is made up of three items;

US$21 million Pension accounting change (Note 1)

US$60 million impact of Extra Week (Note 2)

US$15 million impact of Involuntary Vacation (Note 3)

Note 1 - Figure given by P Saleh in Q&A session.

Note 2 -P
Saleh in Q&A session said GIS impact was US$39m: that GBS and NPS impact
impossible to calculate, but could be anywhere in a range between zero and US$
80million. We have assumed US$21 million within this range.

Note 3 – We cannot calculate the total impact of
forced or involuntary vacation because we do not know the revenue impact.
However, we can estimate the impact on the SG&A line alone, as these
resources do not directly generate revenue. We calculate the impact as approx
US$5 million per day of forced or involuntary vacation. For the sake of this
exercise we have assumed that each SG&A resource took three days of
“involuntary” vacation in Q1 FY2015, meaning vacation they would not have
chosen to take without a directive from the company.

So where does this leave matters?

It reinforced and heightened our concerns about the business fundamentals underlying the published results.

For shareholders, one would be hoping Mr. Lawrie is close to concluding the rumoured sale; because we see nothing to be optimistic about in the company's prospects, and the share price range may not be sustained. In fact it has started to fall.

For employees, the concern is more bad news to come as Mr. Lawrie uses the only business tool he seems familiar with; cost and people take out to maintain profits.

Thursday, 7 August 2014

“First quarter results were consistent with our expectations for the start to fiscal 2015,” said Mike Lawrie , president and CEO. “Our North American Public Sector (NPS) business performed well with sequential revenue improvement and a higher operating margin as we continue to position that business for the uncertain federal spending environment. In our commercial business, we continue to make investments in next generation offerings, strategic partnerships, and sales capacity as we focus on returning that business to growth. We are particularly pleased with the growth we are seeing in our cloud, cyber, and big data businesses.”

Diluted EPS from continuing operations was $1.03 for the first quarter of fiscal 2015.

Total revenue for the quarter was $3.24 billion, down 1% year-over-year as reported and down 2% year-over-year in constant currency compared with $3.25 billion in the year ago period.

Income from continuing operations of $159 million for the quarter compares with $161 million in the year-ago period.

Operating income was $304 million for the quarter, which compares with operating income of $332 million in the prior period. The company’s operating margin of 9.4 percent for the quarter compares with 10.2 percent for the first quarter of fiscal year 2014. The year-on-year change is primarily due to incremental investments in next-generation offerings, sales coverage, and strategic partnerships, as well as the restructuring of a few contracts.

Earnings before interest and taxes (EBIT) were $248 million in the quarter, compared with $269 million in the prior year. EBIT margin of 7.7 percent for the quarter compares with 8.3 percent in the prior year, reflecting the investments and restructurings discussed above.

Operating cash flow of $273 million in the quarter compares with $213 million in the prior year.

Free cash flow of $70 million for the first quarter was an improvement of $79 million when compared with an outflow of $9 million in the year-ago period, and reflects better working capital management.

Ending cash and cash equivalents were $2.4 billion, up from $1.9 billion at the end of the first quarter of fiscal 2014.

Global Business Services (GBS)

GBS revenue was $1.09 billion in the quarter, a 3 percent increase as reported and a 1 percent increase in constant currency when compared with the year ago quarter. Growth in industry software and solutions offset declines in the company’s consulting business, which is being repositioned to focus on higher-value, next-generation technology services. Applications revenue was up slightly year-on-year on a GAAP basis and down slightly year-on-year in constant currency. Operating margin of 9.9 percent compares with 10.7 percent in the year-ago period, reflecting higher investments in new offerings, sales coverage, and partnerships, as well as some higher project costs. Contract awards for GBS were $1.2 billion during the quarter.

Global Infrastructure Services (GIS)

GIS revenue was $1.13 billion in the quarter, a 1 percent decrease as reported and a 3 percent decrease in constant currency from the prior year due to price-downs, contract conclusions, and restructured contracts. An operating margin of 6.3 percent compares with 8.0 percent in the year-ago period, reflecting the impact of price-downs and restructured contracts, along with continued investments in next-generation offerings, sales coverage, and strategic partnerships. Contract awards for GIS were $1.2 billion in the quarter.

North American Public Sector (NPS)

NPS revenue was $1.02 billion in the quarter, a decline of 3 percent compared to first quarter of fiscal 2014, reflecting continued uncertainty in the budget environment at the Department of Defense and other Federal government agencies. The NPS operating margin of 14.8 percent compares with 12.1 percent in the prior year, driven by continued strong cost take-out and favorable contract performance. Contract awards for NPS were $300 million in the quarter.

Returning Cash to Shareholders

During the first quarter, CSC returned $177 million to shareholders, consisting of $29 million in common stock dividends and $148 million of share repurchases. CSC repurchased 2.4 million shares at an average price of $62.28 per share during the quarter. CSC had 145,411,589 basic shares outstanding on July 4, 2014.